Monday, October 3, 2011

A Metaphor to Explain Why Tax Breaks are the Same as Spending

I've read a few articles recently mentioning the rather frequent feigned confusion about how tax breaks are different then spending. I'll give a brief metaphor to explain why the two are identical.

Consider a club that you want to join. The club requires payment of a fairly high entrance fee. The club owner now decides he wants to encourage people to wear Metallica T-shirts. The club owner knows incentive effects are powerful so decides to offer a cash bonus. He suspects people will be upset if he simply hands $5 to everyone that walks in the door wearing a Metallica T-shirt.

Instead, he posts a sign up saying "I'm now allowing you to be a member of the club and keep more of your hard earned money for yourself, wear a Metallica T-shirt and I'll give you $5 off the entrance fee." Then when someone wearing a Metallica T-shirt shows up they pay $5 less. This is identical to the above scenario, but given the rhetoric surrounding this idea on tax issues you'd think there's some kind of real difference in outcomes, when such a difference is logically and mathematically impossible (ignoring timing of a discount vs. a receipt of a payment).

The club owner believes that people will be more accepting of his handing out money to people that love Metallica as much as he does if he advertises it as a discount rather than simply handing out money when people walk in the door. On any rational level however, these two scenarios have exactly the same impact on both the club owner's budget and that of individual club members, people who love Metallica and wear their T-shirts become slightly wealthier than those that don't. This is grossly unfair from the standpoint of anyone who thinks that club membership and fees should be completely unrelated to a member's opinion on Metallica.

The question is, how many people are suckers who will buy the difference between the discount and the handout when both have identical effects on people's income?

I'm pretty sure that everyone that reads this blog understands that spending and targeted tax breaks are identical (some tax breaks can be arguable from an efficiency perspective but they are just as defensible from a spending perspective provided that differences in administrative and oversight costs are ignored since these two factors are not identical between these two policy options), but this is a political tactic I see so often despite its transparency that I feel the need to express my exasperation over it. Who really falls for this framing?

3 comments:

Presumably the people who fall for this framing are the same people who respond to someone using the word "spending" as a shorthand to refer to the effect of tax cuts on the bottom line by saying that this has provided absolute proof that the person using the word in this way believes that all income ultimately belongs to the government rather than the person who made it, no matter how much he or she protests to the contrary.

Also, this is just a nitpick, but the analogy would be more accurate if you changed the membership fee to an entrance fee that has to be paid every time one showed up at the event, since otherwise a difference between the two incentives is that the discount sounds like it would only be applied when one shows up for the first time whereas the bonus sounds like it would be paid out every time one showed up at an event wearing the T-shirt.

Your nitpick is right. I had made the fee structure more complex and more like the government's initially, then decided I complicated the metaphor too much but forgot to change it to an entrance fee (who really wants to read a paragraph explaining the fee structure of the world's most complicated country club). Thanks for pointing that out.